In a recent exercise, we had groups of business people discuss different aspects and attributes of contracting. They discussed the role and value of the process in managing risk, in establishing reputation and trust, in delivering revenue or profit and in supporting operations and outcomes.
Feedback revealed broad consensus that good contracting delivers benefits in all of these areas – or alternatively, poor or disjointed contracting causes damage and under-performance. Yet despite this realization, it rapidly became evident that few organizations have a well-defined process. For example, participants quickly highlighted major problems with input (unclear or badly defined scope and goals) and with transitions (transfer from pre-award to post-award teams). They mostly felt that contracts are not effective governance tools and often lack the terms needed to manage flexibility or change.
How much does this matter? What is the business case or the economic return from ‘good contracting processes’?
IACCM has approached this challenging question in several ways. The reason it is challenging is that data is limited – not least because so few organizations have a coherent process with regular performance measures. Research in 2012 focused on the scale and reasons for value leakage and identified that on average weaknesses in contracting are resulting in losses equivalent to 9.2% of annual revenue. In companies with the most integrated process, this reduced to as low as 3.4% – an impressive difference.
One finding from this study was that there are substantial differences between industry sectors. Therefore more recent research has compared companies within specific industries, exploring whether there is a link between overall profitability and the maturity of the commercial and contracting process. The answer is clearly yes. For example, in the outsourcing industry, profit margins are highly variable, even for companies offering similar services. In examining their approach to contracting, it was quickly evident that some saw this as a life-cycle process, while others viewed it more narrowly as an activity to oversee compliance or control. A few had little evident control; they delegated authority to business units and operated with many variants in contract terms.
Those who viewed contracts as control instruments or who operated with very few controls showed similar results and struggled with their market reputation. They were viewed either as inflexible or unreliable and failing to meet commitments. Both suffered from a high degree of fire-fighting and their contracts were not useful operational tools. They were also perceived as less creative or innovative – too busy fixing things to have time for added-value conversations.
In one select group of 10 companies, the typical margins of those with poor contracting processes were in the range 2% – 5%. Those with holistic approaches to contracting were recording margins of 14% – 16%.
Conclusive proof that good contracting pays a healthy dividend? Perhaps not; there are of course wider factors to take into account. But there seems little doubt that the quality of contracting is a significant contributor to profitability – or failure to develop competence in this area carries a heavy cost.
There is growing appreciation that collaborative relationships generate better results. On one level, it is surprising that anyone ever thought otherwise, but market pressures over recent years have caused fundamental realignments in buyer / supplier relationships. These changes have undermined trust and often created a high level of contention and adversarialism.
Now, the pendulum is swinging back, there is a new level of openness in business relationships and a greater readiness to discuss shared risks and responsibility. Achieving this demands a shift in the negotiation agenda and greater focus on governance and performance management principles and process.
However, the transition is not easy. Today I have been leading a workshop on collaborative supply relationships and the participants shared what they saw as the major barriers to change. Top of their list came a lack of trust – but of course this is a symptom of other things and will not be fixed without addressing the causes. Here are the top five (by frequency) that they identified:
- Resistance based on the view that collaboration takes too long (to reach decisions) and undermines accountability
- Different objectives / mismatched KPIs / silos between stakeholders
- Competitive bidding / re-tendering practices
- Unclear process, especially with regard to roles and responsibilities
- Unclear benefits of collaboration – both organizational and personal
I find it interesting that the group saw internal barriers as the major challenge. No one mentioned resistance or reluctance by the counter-party (though this audience was from the customer side and I suspect a supplier audience might generate a different list).
Fortunately, we were able to work on some immediate practical steps that will increase collaboration – but it is clear that there are significant obstacles to be overcome before the benefits can be realized.
“Optimism is the enemy of action”, according to a recent article in The Atlantic Magazine.
The article reviews a recent book by Dr. Gabriele Oetiggen which questions the benefits of positive thinking. Based on some 20 years of study, Dr. Oetiggen concludes that ‘positive thinking’ often equates to unbridled optimism and leads to a failure to recognize or address obstacles. She therefore introduces a new concept which she calls ‘mental contrasting’.
It seems to me that any experienced contract or commercial manager will already be familiar with this particular syndrome. Indeed, any successful business already addresses the issues highlighted by Dr. Oetiggen through its organizational structure and management systems. Groups such as Sales are recruited and paid to be optimists; commercial staff in contracts, legal and finance are there to address realities. The key is of course to achieve balance – or ‘mental contrasting’.
Problems arise mostly when senior management is over-optimistic and either does not seek or chooses to ignore commercial advice. This again has been identified on a number of occasions, including work undertaken by ICCPM in partnership with IACCM, which led to a paper, ‘The Conspiracy of Optimism”. The good news is, it did not take 20 years, a book, or a new nomenclature to identify the issues!
High-performing organizations often view contracts – and the contracting process – as a form of ‘connector’. They understand that the process draws together the views and interests of a wide variety of stakeholders. It acts as a method to reconcile disparate views, which are then reflected in the agreed terms of contract.
Connectivity does not end there, because the contract is then used as a management tool to support implementation and performance management, ensuring a series of connections throughout the lifecycle. Under this approach, contracting is a source of quality control and protects against value erosion.
While this may be true for a few leading organizations, it is not the norm. In a recent IACCM survey, members were asked to rate the capabilities of their organization against a range of key maturity indicators. More than 300 corporations are represented in the results, which show encouraging growth of executive interest – one might say awakening – in the role that contract management can play in today’s increasingly complex and volatile business environment. To some extent, that interest has been reflected in investment, though the results show this to be rather variable.
There are interesting differences between regions – for example, who would have thought that the region with the biggest growth in capability over recent years would be South and Central America, or that the region with the greatest increase in management awareness would be the Middle East. But of course, different regions have very different start points – and the findings suggest that most organizations have many opportunities for continued improvement.
A summary of the results from this survey will feature on a free webinar to be aired on October 21st and which will then be added to the IACCM library. To register, visit the event website.
One challenge facing contract and project managers is how to improve their anticipation of problems. Contract administration was mostly a reactive discipline, reporting after the event. Contract management should be far more proactive, seeking to anticipate and remediate issues before they become major problems, leading to potential claims or disputes.
The question is, what are the warning signs? We recently posed that question to a group of experts within IACCM and they produced the following list – a sort of ‘top ten’, though in no particular order of priority. We plan to add to this list and increase its sophistication because it represents important knowledge and insight which may assist many in delivering greater value through improving project success – avoiding delays, budget overruns and quality defects.
Here is the list of things to watch out for, to measure or to test; please add to it, change it and comment upon it.
Actual versus plan cost or cash flow
Finger-pointing / blame
Lack clarity over authority / decision-making
Failure to maintain / update business case
Staffing not in accordance with plan
Disputes / disagreements over change
KPIs / measures inconsistent with goals
Poor or incomplete documentation
User dissatisfaction or disengagement
There is growing evidence that the form and design of a contract has substantial impact on the results achieved. The evidence ranges from studies on major projects, which often suffer from use of the wrong contract model, to more focused investigation of the behavioral impact of specific terms, such as the liability or indemnity provisions.
The steady move away from traditional product-based sales into a world of solutions and services is changing the emphasis of contracts. Rather than each transaction being driven by a specific delivery or input, many agreements now relate to phased activity where ‘completion’ is rather less precise and ‘success’ can be gauged only over time and linked to an extended output or outcome.
Inevitably, this leads to a growing interest in outcome and performance based contracts. Yet according to the input to a current study, their use remains limited and contract professionals generally develop them through ‘trial and error’. There are also some important differences in perspective between the customer and supplier community. For example, suppliers have recognized the extent to which extended performance periods depend on active cooperation with their customer (and potentially their numerous sub-contractors); buyers seem slower to grasp or accept this point. Both buyers and suppliers appear slow to accept the organizational and operational implications of this enormous shift in the contracting model.
These are among the early, high-level conclusions from a survey IACCM is undertaking in partnership with Newcastle University Business School (UK) and the University of Paderborn (Germany). The research includes insights to the types of outcome based agreements most commonly used, the nature of the benefits and the challenges with their implementation and management. The overall output from this study will include not only the research results, but (over time) more detailed recommendations on different models for outcome and performance based contracts.
If you complete this survey, you will of course automatically receive a copy of the results and be invited to a webinar with the academics conducing the research. Please visit http://ww3.unipark.de/uc/contractingforsolutions/ to participate.
Last week I was running a capability review with an IACCM member company. During a break, one of the attorneys said that he had been struck by the session we had just done on communications and told me a story about his former company.
He explained that this organization was a leader in its field and based its success on engineering excellence. Its technical and production teams were especially proud of the quality of their designs and their associated documentation.
However, like so many manufacturers, they faced market pressure to cut costs and therefore decided that manufacturing must move to low-cost facilities; they opened a plant in Mexico and transferred all their know-how via the manuals and instructions used in the US and Canadian facilities. Unfortunately, quality plummeted. Many were quick to blame Mexican workers – they were accused of being less skilled, having bad attitudes, being incapable of training. But someone in senior management was smart enough to understand that all that state-of-the-art documentation (of which the production engineers were so proud) was actually the problem. It was too difficult to understand – not only because it was in English, but also because it used words and was complex to follow.
Translation was not enough; the documents needed a re-think in both form and structure. They were re-designed to maximize use of graphics and to be visible at understand them. each phase of the production process, to the people who needed to understand them. Quality levels soared, soon surpassing those of the other plants.
The analogy to contracts is obvious. These increasingly complex documents contain a wide array of operational instructions, yet are rarely designed to make things simple or obvious. As a result, there is then either an expensive translation process, or quality of performance suffers.
Those engineers in my story were among the best professionals in the world, but if someone had not intervened to make their work comprehensible they might have destroyed their company. As contract and legal professionals, are we similarly putting our companies at risk?